As Italian Vote Looms, Currency Vigilantes get Ready to Strike Again

The newly empowered currency vigilantes are slated to get their latest chance to pounce by Italy’s constitutional referendum.

The best way to express concern that Prime Minister Matteo Renzi’s reforms will become the latest victim of a rising populist mood is the euro and not Italian bonds according to investors. Traders are speculating that the European Central Bank may backstop bonds in the event of a “no” result — supporting debt markets while further undermining the single currency while both assets have fallen in the run-up to the Dec. 4 vote.

Euro’s decline is seen enduring even after a “yes” vote as Donald Trump’s election continues to boost the U.S. dollar and this is seen making the hedge more attractive.

In Europe at least, central-bank easing has nullified their impact. Currency traders have picked up the mantle while so-called bond vigilantes used to prowl the market dispensing fiscal discipline by forcing up borrowing in countries they saw as erring from the right path. Currency traders have picked up the mantle has been picked up currency traders. In the aftermath of the U.K.’s vote to leave the European Union, their impact was seen.

While bonds jumped amid expectations, the pound bore the brunt of investors’ displeasure.

James Athey, a money manager in London at Aberdeen Asset Management Plc, which oversees more than $400 billion said that selling the euro before Italy’s vote “makes a lot of sense given the potential for more expansionary fiscal and tighter monetary policy in the U.S., coupled with the increased focus on political risk and the increased likelihood of more policy from the ECB.”

With no wagers on European bonds, but positioned for a decline in the euro, the company is planning to head into the vote.

Matching its highest close since June, when Britain voted to leave the European Union, the two-week implied volatility for the single currency versus the dollar jumped on Monday by 1.39 percentage point to 11.41 percent.

“For FX, politics is the new economics. QE has constrained the bond market, distorted equity prices and narrowed yield differentials. This means FX is uniquely placed to reflect political developments,” HSBC Holdings Plc analysts including David Bloom wrote in a note last week.

Speculations that the reforms on which Renzi has staked his political future would be rejected have been boosted by Trump’s election. While political risk-advisory firm Eurasia Group changed its call this month, and now assigns a 55 percent probability to a “no” vote, Deutsche Bank AG economists say there’s a 60 percent chance the vote will fail.

“Markets are anticipating two risks at the moment: reflation and populism in Europe. If one thinks that the Italian referendum is going to be lost, and it’s not priced in, selling the euro — which is also being weighed down by other factors — seems the path of least resistance compared with a rate position,” said Marc Chandler, head of currency strategy at Brown Brothers Harriman & Co. in New York.

Aurelija Augulyte, a macro strategist at Nordea AG, who’s advising clients to sell the currency against the pound before the vote said that if European risks rise, the euro will take the hit. “The pound is still very cheap, and will look much better in light of any unrest in the European political landscape,” she said. “It’s an intra-Europe, relative-value bet.”